Financial Management - Mba

Study Notes- MBA I st year, Financial Management
Financial Management
From
Megha Ahuja
Assistant Professor, Graduate School of Business, Tula’s Institute, Dehradun
Introduction
All the resources of an organisation are indispensable but financial resources
have their own importance as funding is required by all the departments and
at all the levels of a company. It is essential to optimally utilise this
resource, as it is a limited resources with alternative uses.
Finance is one of the most important functional area of business and within
business firm. It joins other functional area like marketing,
operation, technology and management as key areas of business.
From Megha Ahuja Assistant Professor, Graduate School of Business, Tula’s Institute, Dehradun
Meaning of Finance
Every enterprise whether big, medium or small needs finance to carry on
its operations and to achieve its target. In fact, finance is so
indispensable today that it is rightly said to be the lifeline of an
enterprise. Without adequate finance,no enterprise can possibly
accomplish its objectives. Now let us understand the meaning and
definition of finance.
In general usage finance means money or funds. It means to create

provision of money at the time when it is required. But in business world,
it has little different meaning.
Definition of Finance
Finance is defined as science of money management.
According to Khan & Jain " Finance is the art & science of managing money"
According to Oxford Dictionary the word finance connotes "management of
money"
According to Webster Ninth New Collegiate define finance as " science or
study of management of funds"
Thus, finance may be defined as art and science of making money. It includes
i) Financial services and 2) Financial management (business(managerial)
finance / corporate finance)
Meaning of Financial Management

Finance is called science of money management. It is not only making
money available but its administration and control is very much
required so it could be properly utilized. To understand its detail
meaning let us discuss definitions given by eminent authors which are as
following:-
Definition of Financial Management

Some important definitions of financial management are as following:-
According to Phillippatus " Financial Management is concerned with the

managerial decision that result in acquisition and financing of short
term and long term credit of the firm"
According to Raymond Chambers " Financial Management comprises the

forecasting, planning, organising, directing, co-ordinating and controlling
of all activities relating to acquisition in keeping with its financial objective"
According to Howard & Upton " Financial Management is an

area of financial decision making harmonising individual motives
and enterprise goals"
According to I.M. Pandey " Financial Management is that

managerial activity which is concerned with the planning and
controlling of firm's financial resources "
Thus, Financial Management can be defined as specialised activity/part

of management activity which is concerned with efficient acquisation/
procurement of finance, its effective utilisation ( investment in assets,
working capital etc.) and proper disbursement of dividend to
shareholders so that individual, organisational and social objectives are
accomplished. Financial Management is practised by many business or
companies which can be called as business or corporate finance.
Financial management is the art of planning, organising, directing and

controlling of the procurement and utilisation of funds and safe disposal
of profit to the end that individual organisational and social objectives are
accomplished.
Financial Management refers to the part of the management activity,

which is concerned with the planning and controlling of firm's financial
resources. It deals with finding out various sources for raising funds for the
firm.
Nature/Characteristics/Features
of
1. It is essential part of business management.
2. It is both science and art
3. It is base of all managerial decisions.
Nature / Characteristics / Features of

4. It is centralised function.
5. It is concerned with effective procurement,
utilisation and ultimate disposal of funds.
6. It is continous administrative function.

7. It includes financial planning, control and
follow-up.
8. It helps in maintaining balance between
risk and profitability.
9. It is different from financial accounting

10. Scope of FM is very wide and complex.
11. It is applicable to all types of organisations.
12. It is related with different disciplines like
economics, accounting, law, information
technology, mathematics etc.
Objectives
of
Financial
Management
Objectives of Financial Management

Effective procurement and efficient use of finance leads to proper
utilisation of the finance by the business concern. It is an essential
part of financial management. Hence, the financial manager must
determine the basic objectives of financial management. Objective
of financial management may be broadly divided into two parts such as
• Profit maximization
• Wealth maximization
Profit Maximization
Profit maximization decision criterion- Main aim of any kind of economic
activity is to earn profit. A business concern also functions mainly for the
purpose of earning profit. Profit is a measurement technique to understand
the business efficiency of the concern. It provides a yardstick by which
economic performance can be judged.
This objective/approach was developed in the early 19 century. It is
a traditional and narrow approach which aims at maximizing the profit of
the concern.
According to this approach, actions that increase

profits(total) should be undertaken and that decrease
profit are to be avoided. In specific operational terms,
as applicable to financial management, the profit
maximization criterion implies that the investment
financing and dividend decision of a firm should be
oriented to the maximization of profit /EPS.
in other words, profit can be maximized either by
increasing output for a given set of scarce resources
or by reducing the cost of production for giving output
resources.
Favourable arguments for profit maximization

The maximization of profit objective is often considered because of the following
reasons:-
i) This objective is simple and well accepted.
ii) It guides to financial decision making
iii) Profit is a means of judging the economic performance of an enterprise.
iv) It leads to efficient allocation of resources, as resources tend to be directed
to use in terms of profitability, which are one of the most desirable.
v) It ensures efficient use of economic resources.
vi) It leads to total economic welfare and is maximized.
vii) Profit reduces the risk of the business concern.
vii) It is a main source of finance for the growth of business.
Unfavorable arguments for profit maximization

The following important points are against the objectives of
profit maximization
i) Profit maximization leads to exploiting workers and consumers.
ii) It creates immoral practices such as corrupt practices, unfair trade
practices etc.
iii) It leads to inequalities among the stakeholders such as customers,
suppliers, public shareholders etc.
Drawbacks of profit maximization

Profit maximization cannot be the sole objective of the
company. If profit is given undue importance, a number of
problems can arise.
The main technical flaws are
i) Ambiguity
ii) Timing of benefits /Does not consider time value of money
iii) Quality of benefits/ Ignores risk
i) Ambiguity
One practical difficulties with profit maximization
criterion for financial decision making is that profit is a
vague and ambiguous concept. It doesn't clarify what
exactly it mean. It is amenable to different interpretations
by different people.
To illustrate, profit maybe
• short-term or long-term
• before or after tax
• return on total capital employed or total asset or
shareholder equity and so on.
Ambiguity….
If profit maximization is taken to be objective, the
question arises which of these variant of profit should a
firm try to maximize. A loose expression like profit cannot
form the basis of operational criteria for financial
management.
ii) Timing of benefit/Does not

consider time value of money
Profit maximizing objective approach does not consider time
value of money or net present value of cash inflow. It doesn’t
help in making a choice between projects giving different
benefit spread over a time.
Time Pattern of Benefits (Profits)
Time Alternative A (Rs. In thousand) Alternative B (Rs. In thousand)
Period I 50 -
Period II 100 100
Period III 50 100
Total 200 200
It can be seen from the above table

Total profit associated with the alternative A and B are identical/same.
If profit maximisation is the decision criteria, both the alternatives would be
ranked equally.
But the returns from both the alternatives differ in one important respect, while
alternative A provides higher returns in earlier years, the returns from alternative
B are larger in later years.
As a result, the two alternatives course of action are not strictly identical.
A basic/ famous dictum (काहवत) of Financial planning is

that "the earlier, the better"- as benefits received sooner
are more valuable than benefits received later.
The benefits received earlier can be reinvested (in the
mean time, further benefit received) to earn a return.
This is referred as time value of money.
The profit maximization criterion does not consider the
distinction between return received in different time
periods and treat all benefits irrespective of the timing, as
equally valuable.
Ignores risk
Profit Maximization objective/approach does not consider
risk of the business concern.
There is direct relationship between risk and profit. Many
risky proposition yield high profits. Higher the risk, higher is
the possibility of profits. If profit maximisation is the only
goal, then risk factor is altogether ignored. This implies that
a financial manager will accept highly risk proposals, if they
give high priority to profit.
In practice, risk is a very important consideration and has to
be balanced with the profit objective.
From the above it reveals that profit maximisation objective is

inappropriate and unsuitable as an operational objective of the
firm. Suitable and operationally feasible objective should be
precise and clear cut and should give weightage to time value and
risk factor.
Wealth
Maximisation
Wealth Maximisation
Wealth maximization is universally accepted as an
operational decision criteria for financial management
decision. It removes the technical limitation which
characterize the earlier profit maximization criterion. Its
operational features satisfy all the three requirements of a
suitable operational objective of financial cause of action
namely exactness, consider time value of money and risk.
The term wealth means shareholder wealth or wealth of a
person those who are involved in business concern. Wealth
maximization means/involves creating and increasing
shareholder's (owners) wealth.
In simple words, if a company performs above expectation
then returns are given as dividend to shareholders. This
increase the value of the company's shares in the market and
with rising demand and limited supply (maximum issue of
shares upto authorised capital) the market price of the share
also increases. This, in turn, increases the worth of capital
invested by shareholders in the form of capital appreciation.
Wealth maximization is also known as value maximization on
net present worth maximization. It is considered better
operational goal because it is based on cash flow rather than
profit. Cash flow is a concise and clear term. It hardly lack
precision. Measuring benefits in terms of cash flow avoids
ambiguity associated with accounting profits.
Wealth maximization considers time value of money. It

recognise that cash benefits emerging from a project in
different years are not identical in value. (Annual cash
benefits of a project are discounted at a discount rate
to calculate total value of these cash benefits)
It not only incorporates time value of money and also
consider return and risk associated with a project. It
does by choosing an appropriate rate of discount and
using this rate to find out net worth of future benefits
by discounting the future stream of benefits by this
rate.
Wealth or net present value is the difference between

gross present worth and amount of capital investment
required to achieve the benefits.
Net present worth/value=
Gross present worth/value - Amount of capital
Where,
Gross Present Worth-
Present value of expected cash benefits discounted at a
rate which reflects their certainity and uncertainty.
Where,
W=Net present worth
A=Expected benefit over a period of time
K= Appropriate discount rate to measure
risk and timing.
C= initial outlay to acquire the asset
t= time period
Thus, wealth maximisation objective as decisional criterion suggest

that any financial action which creates wealth or which has a net
present value (NPV) above zero is desirable one should be accepted
and others which do not satisfy (NPV) should be rejected.
Important features of wealth maximisation criterion

i) The concept of wealth is clearly defined and easy to understand.
ii) It serves as a very useful guideline for taking investment decisions
iii) It represents present value of benefits of minus cost of the investment.
iv) It is consistent with the objective of maximizing the economic welfare of the
shareholders of a company.
v) It considers both the quantity and quality dimension of benefit.
vi) It also incorporates the time value of money and risk factors.
vii) It considers that the shareholder wealth is maximized only when the market
value of share is maximized.
viii) It is also consistent with the personal objectives of manager such as
recognition, power, status, personal wealth et .
viii) It removes the limitation of profit maximization decision criteria
Favourable arguments for wealth maximisation

i) Wealth maximisation is superior to the profit maximization
because the main aim of business concern under this concept is
to improve the value or wealth of the shareholders.
ii) Wealth maximization considers the comparison of the value
to cost associated with the business concern.
iii) Wealth maximization considers both time value of money
concept and risk of the business concern.
iv) It provides efficient allocation of resources.
v) It ensures the economic interest of the society.
Unfavourable arguments for wealth maximization

i) Wealth maximization is nothing, it is also profit
maximization, it is the indirect name of profit maximization.
ii) It creates ownership-management controversy.
iii) Management alone enjoy certain benefits.
iv) The ultimate aim of wealth maximization objective is to
maximize the profit.
v) Wealth maximization can be activated only with the help of
profitable position of the business concern.
Difference
between
Profit maximisation objective
and
Wealth maximisation objective
S. Basis of Profit Maximisation Wealth Maximisation
No. Distinction
1) Nature The concept of profit maximization The concept of shareholder wealth
/concept implies that a firm either produces maximization means maximizing the
maximum output for a given input or wealth in the hands of shareholders by
uses minimum inputs for producing a way of dividend and value creation or
given output. Thus, it relates to net present value (NPV) of a course of
optimising the input-output relationship action such that future inflows value is
of resources to minimise the wasteful maximized and determined precisely.
cost.
2) Purpose The main purpose of profit The main purpose of this concept is to
maximization is to maximize the enhance the value of the firm and the
profitibility derived out of economic market value of the shares of the
activity of the business. shareholders.
3) Formulae The concept is based on the The stockholder's current status of
determination of maximization of wealth in the firm is based on the share
profits. In simple way, price and the number of shares held. It
Profit= Total revenue receipt-Total can be depicted as:-
cost Wealth= No. of shares owned × current
stock price per share

No. Distinction
4) Rationale The rationale behind this concept is the The rationale behind this concept is
need for maximum profits and maximization of the value of the firm
accumulated profits for growth in and enhancing shareholders wealth as a
future and shelter against gratitude for their commitment of
contingencies like economic recession, funds and continued investor
national calamity, unforeseen losses in relationship with the company.
future, severe competition etc.
5) Time span The concept relates to relatively This concept relates to long term value
shorter time period, say a financial building and augmenting individual
year. Thus, a short term myopic vision. shareholder's utility. Thus, a long-term
vision.
6) Time value of This concept does not give due This concept give due consideration to
money consideration to the issues of time the time value of money and its
value of money. It determines profits implication. it calculate the future
for the financial year and ignores the earning, at their exact value by applying
discounting factor of earnings. net present value (NPV) approach and
discounting factor etc.
No. Distinction
7) Immediate The immediate benefit of this concept The immediate benefits are availed by
beneficiaries is derived by management and later by shareholder and later by the
the shareholders, especially when there organisation as a whole. This can
is separation of management from potentially cause conflict when there is
ownership. separation of management from
ownership.
8) Limitation and The profit maximization concept has The wealth maximization concept has
constraints following constraints the following constraint
• It ignores the time value of money. • It suffers from drastic changes and
• Short term vision based fluctuations in financial markets.
• Explorative tendency towards • Tendency to overlook short term
resources, employees, customers if economic objectives of the business
this concept is pursued beyond viable • Very long span of time, so increase
limits efforts on value building
• Term of profit is vague • Conflict arises when there is a
• Ignores risk separation of management
• Give lower priority to the
shareholder's interest
Other important objectives of financial management
The following are the objectives of financial management
• To provide reasonable return to shareholders/investors of a business
Concern
• To ensure maximum utilisation of available financial resources efficiently
and effectively.
• To plough back profits for growth and expansion.
• To exercise appropriate control measures so as to secure financial discipline
in the organisation.
• To co-ordinate among the various departments of a business concern to
ensure smooth functioning of the operations.
• To ensure optimum level of leverage.
• To facilitate minimization of financial charge.
• To ensure growth of earning per share and market value of the share.
•

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Study Notes- MBA I st year, Financial Management

In general usage finance means money or funds. It means to create

Meaning of Financial Management

money available but its administration and control is very much

required so it could be properly utilized. To understand its detail

meaning let us discuss definitions given by eminent authors which are as

Definition of Financial Management

According to Phillippatus " Financial Management is concerned with the

According to Raymond Chambers " Financial Management comprises the

According to Howard & Upton " Financial Management is an

According to I.M. Pandey " Financial Management is that

Thus, Financial Management can be defined as specialised activity/part

Financial management is the art of planning, organising, directing and

Financial Management refers to the part of the management activity,

Nature / Characteristics / Features of

Nature / Characteristics / Features of

Nature / Characteristics / Features of

Objectives of Financial Management

According to this approach, actions that increase

Favourable arguments for profit maximization

Unfavorable arguments for profit maximization

Drawbacks of profit maximization

ii) Timing of benefit/Does not

It can be seen from the above table

A basic/ famous dictum (काहवत) of Financial planning is

From the above it reveals that profit maximisation objective is

Wealth maximization considers time value of money. It

Wealth or net present value is the difference between

Thus, wealth maximisation objective as decisional criterion suggest

Important features of wealth maximisation criterion

Favourable arguments for wealth maximisation

Unfavourable arguments for wealth maximization

S. Basis of Profit Maximisation Wealth Maximisation

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